What To Do About Debt

In today's American society, debt has become so common that the savings rate is nearing 0%, and runs a substantial chance of becoming negative. Financing has become so easy to get that anyone can get it -- creditors will extend financing, particularly for collateralized loans but also for unsecured loans like credit cards, to anyone with a pulse. Of course, they do so at "subprime" rates (i.e. extremely high interest and unfavorable terms), but they still do it.

The deluge of easy credit, brought on mainly by low interest rates, has resulted in a lot of people spending more money than they reasonably can afford to. Now, fundamentally this is a problem of personal responsibility -- if you can only get credit at 29.99% interest, you shouldn't be using credit -- but what's done is done, and the money people have already spent can't be un-spent. So now you get people who owe $2,000 on a card, pay $3,000 on it over the course of a year, and end the year owing $4,000 despite not making any new purchases. How? Penalties and fees, of course. Once people have their credit card accounts go over the limit, they get hit with an over-limit fee every month; if they can't afford to pay the minimum balance, they get a late-fee every month, too... and those fees are not included in the minimum payments, so the principal actually increases over the course of the year. They're literally in over their heads -- they've incurred so much debt at such lousy terms that they can't possibly pay it all, as the debt service requirements exceed their income.

So my question is, in a libertarian society, what do you do about this problem? And while the market will solve many things, this is still a societal issue, because you have to do something with them -- inaction is, in this case, an action.

Well, there are a few basic ways this problem has been addressed historically:

* Repossession: When someone can't make payments for a debt they've contracted to, the creditor comes over to their house and takes stuff equal to the value of the debt. Pros: creditor gets repaid, debt goes away. Cons: what if the person's debt exceeds the value of their property? Then the creditor can't possibly take enough to repay the debt, so the debtor loses their property and still has an untenable debt. And repossessions of some assets (e.g. a car) may make it more difficult for the debtor to work and thus repay the debt. This may solve the problem for small debts, but not for large ones -- and the large ones are the problem in the first place.

* Debtor's Prison: When someone cannot make payments according to the terms of the contract, you throw them in jail. Pros: powerful deterrent to taking on debt you can't pay. Cons: creditor is screwed; they loaned money out, and they don't get any back. And since the person's in jail, it's not like they're going to make any money to repay the debt. So who does it benefit? Both the creditor and debtor are unhappy.

* Indentured Servitude: When someone cannot make payments according to the terms of the contract, they have to work for the creditor until the debt is repaid, or for a term specified in the contract. Pros: Powerful deterrent to taking on debt you can't pay. Creditor at least gets some value for the bad debt. Cons: Creates a legal underclass, with all the sociopolitical and moral dangers that entails. Slavery is unseemly in a civilized society. May decrease total value, if the work done for the creditor pays less than the debtor's free occupation.

* Bankruptcy: When someone cannot make payments according to the terms of the contract, they go to a judge and declare bankruptcy. The judge liquidates most of their assets and repays creditors in order of debt seniority. Then all the debt is declared void, and the person starts over. Pros: Some creditors get something, debtor gets a fresh start in life without being completely destitute. Cons: Some creditors still get screwed -- filing bankruptcy is theft, plain and simple. In addition, the lack of penalty for the debtor encourages people to take out more credit than they can support. The easier it is to declare bankruptcy, the worse this unintended consequence is. To cover bankruptcy risk, creditors raise rates for everyone else. Potential for abuse -- since some assets are shielded, some people find ways to declare bankruptcy while remaining rich.

Well, given the choices above, bankruptcy (theft and all) looks downright peachy by comparison. Also, things to consider when addressing this issue:

* Involuntary debt: Debt for medical bills or for negligence fall into this category. You didn't choose to have a heart attack, but you'd rather go into debt than die, and now you owe the hospital five years' salary. Alternately, you didn't mean to set the barn on fire, and have no contract with the owner, but now you owe him five years' salary. There are no contract terms in these cases, so there must be a legal standard -- "freedom of contract" provides no guide in cases of involuntary debt, so even if you go with that option for voluntary debt, you have to do something with these cases.
* Usurious terms: Subprime credit cards are scary; after missing payments you genuinely can pay the entire balance every year and owe more each year. I would presume a libertarian society would not outlaw such terms -- they are, after all, a mutually agreed contract -- but people often stupidly sign up for them when they shouldn't, and this creates an issue where people can repay the debt, but not the "service fees" thrown on it constantly. Does freedom of contract extend this far, or does it violate conscionability requirements?

So, what would a libertarian nation do when faced with a debtors' society like ours?